Modi Unlikely to Overhaul India’s State-Owned Giants

Indian Prime Minister Narendra Modi is implementing an ambitious plan to reform the country’s central public sector enterprises (CPSEs) – companies owned by the federal government. However, rather than liberalizing the market and privatizing the firms, the initiative may end up consolidating the government’s hold over the economy.

During the election campaign in the summer of 2014, Mr. Modi promised “minimum government, maximum governance” as his guiding philosophy for the economy. His oft-repeated mantra both before and after the election was that “the business of government is not business.” Yet many who expected big economic reforms, especially the privatization of many of the CPSEs, have been disappointed.

In the past three years, the government claims to have raised almost 880 billion rupees ($14 billion) from “disinvesting” its holdings in CPSEs, an increase of over 60 percent from the previous government’s last three years in power. “Disinvestment” is a frequently used euphemism in India for the government selling stakes in state-owned firms while retaining controlling or significant shares. Full-blown privatization is unpopular and politically contentious.

In the annual budget presented in February 2017, the government proposed an ambitious plan to raise another 720 billion rupees (about $11 billion) from disinvestment. There is reason to be skeptical that it will reach this target. Over the past decade, on average, less than 60 percent of the annual disinvestment goal has been met. The increased revenue from disinvestment in the past three years has come from public offers issued by listed CPSEs, many of which are oligopolies.

Government in Business

There are about 235 CPSEs, which account for about 20 percent of the country’s gross domestic product (GDP). The 47 of them that are listed on the Bombay Stock Exchange account for about 12 percent of the bourse’s market capitalization. There are also about 1,000 public sector enterprises owned by state and local governments.

Many of these firms are inefficient and burdened with debt. About two dozen CPSEs are estimated to have loans greater than their total assets; around 80 generate too little operating profit to cover the interest on their loans. According to some estimates, a third of India’s CPSEs made losses in the fiscal year ending in March 2016. A fifth of CPSEs have been in the red for three straight years.

Still, the political and social appetite for improving these firms’ performance by moving them to the private sector has been limited. Privatization remains a political taboo, and “disinvestment” has been the preferred method across the political spectrum. Over the last two decades, India has had a Disinvestment Commission guide the government on how to sell its stakes in CPSEs, and the Department of Disinvestment to implement the process.

From 2000 to 2003, when Prime Minister Atal Bihari Vajpayee (one of the founding members of Mr. Modi’s party) led the National Democratic Alliance coalition government, important strides were made. Some 30 companies were privatized, including chemical, computer and automotive firms, as well as many hotels. But other than that short spurt, India’s disinvestment process has been creeping along for the past 25 years. The main objective has been to raise revenue to reduce the fiscal deficit, with very limited success.

The Track Record

Against this backdrop, Mr. Modi’s repeated assertion that “the business of government is not business” was bold. It spurred hope for dramatic reforms, and even privatization. As the head of the Gujarat state government for 12 years, Mr. Modi did implement a few initiatives to streamline administration and improve the performance of some government enterprises, particularly in the power sector. However, privatization was not among his preferred strategies.

Last year, NITI Aayog, the government think tank, was asked to provide a road map for reforming CPSEs and take over the role previously played by the Disinvestment Commission in identifying the CPSEs for disinvestment and suggesting the appropriate strategies. The document has not been made public, but according to media reports, NITI Aayog looked at 76 mostly loss-making CPSEs and suggested a slew of options – from closure, to strategic sale, restructuring and disinvestment, as well as consolidating and retaining a few companies.

5 hold properties on lease from state governments that could be either sold or leased to the private sector or returned to the states; these mostly include hotels

3 need to be merged with their parent companies

2 should be maintained as they are

For about 20 others, NITI Aayog said any decision on their sale should be taken only after recovery plans are fully implemented

For a few others, further assessments are needed to come to any decision

In the meantime, Mr. Modi’s government also changed the name of the Department of Disinvestment to the Department of Investment and Public Asset Management (DIPAM). The move implies that the government is reviewing the strategy of gradual liberalization, and the 25-year-old process of slow privatization via disinvestment may be discontinued. The government considers the CPSEs as assets and investments and wants to maximize the revenue they generate, more by improving their returns than from selling stakes to the private sector. At times, this will mean even strengthening oligopolies.

The government faces three big obstacles. First is the question of valuation. It is commonly believed that many of the CPSEs are sitting on vast amounts of land. What is not so well understood is that in many cases, the CPSEs may not actually own the land, and may have been given the land on lease by the state or local government, or some other government agency. Given the poor state of India’s land records, this is not a surprise.

Secondly, there are lawsuits affecting quite a few CPSEs, including some where restructuring and revival are proceeding under court orders. Some firms are unlikely to find a buyer unless their debt is restructured or written off. The third challenge is to figure out how to smooth the transition for these companies’ employees. This raises even more difficult social and political questions than valuation. Many unions regularly protest disinvestment.

The Road Ahead

The Modi government has so far disinvested from two CPSEs. In April, it sold a 9.2 percent stake in National Aluminium Company, reducing the state’s holding to 65.4 percent. In May, it floated 10 percent of Housing & Urban Development Corporation in an initial public offering on the BSE. Almost 70 percent of the company’s portfolio consists of government-sponsored urban infrastructure projects. The government has also decided to transfer three hotels managed by India Tourism Development Corporation to their respective state governments.

Coal India Limited (CIL) typifies the problems facing the government. It is among the seven CPSEs considered “Maharatnas” or “Great Jewels.” It is one of the world’s largest coal producers, operating more than 400 mines and holding an 80 percent share of the Indian market. It is also sitting on a cash pile of over 500 billion rupees, the largest among CPSEs. However, its output has fallen over the past year as the sluggish economy and the poor financial health of many state-owned electricity companies hurt demand.

‘Jewels’ in the crown CPSEs operate in a diverse array of sectors, including agriculture, airlines, housing, banking, engineering, insurance, telecommunications, transportation, mining, medicine, energy, insurance, hotels, railways, shipping and steel. Thirty-five federal government ministries oversee various CPSEs. Based on size and performance, 235 CPSEs have been categorized as “Ratnas” (“Jewels”) by the Indian government. The seven largest CPSEs are called “Maharatnas” (Great Jewels):

Bharat Heavy Electricals Limited (BHEL)

Coal India Limited (CIL)

Steel Authority of India Limited (SAIL)

GAIL (India) Limited

Indian Oil Corporation Limited (IOC)

NTCP Limited

Oil & Natural Gas Corporation Limited (ONGC)

There are also 17 “Nav Ratnas” (“New Jewels”) and 73 “Mini Ratnas” (“Mini Jewels”), among others. The total assets of all 235 Ratnas have been estimated at about 30 trillion ($500 billion). Many CPSEs also own subsidiary companies, which when included brings the list to around 370 state-owned firms. There are also 22 public sector banks (PSBs), which are generally not included in this list of CPSEs. In addition, state and local governments own around 1,000 companies.

For the current financial year, the government reduced CIL’s production target by 10 percent, from the original target of 660 million tons. Last year CIL managed to produce only around 550 million tons, again about 10 percent below its target. At the same time, the government has asked CIL to tap into its cash reserves and invest in a 1,000-megawatt solar power project, as part of India’s renewable energy push.

For the past 18 months, the government has been trying to sell 5-10 percent of its 78 percent holding in CIL, with little success. It is expected to make another attempt this year. In 2016, CIL offered to buy back about 1.7 percent of its shares, generating some 26 billion rupees for the government. Adding to CIL’s woes are concerns expressed by quite a few international pension funds and financial institutions regarding environmental, labor and safety practices.

Cash Cows

Of the 119 unlisted CPSEs that are profitable, 10 account for two-thirds of those profits. If these 10 firms were listed, their market capitalization could reach 5 trillion rupees. The government could potentially raise about a quarter of that through disinvestment, since the listing criteria requires that the government divest 25 percent of CPSEs’ shares over a three-year period.

There are 34 cash-rich CPSEs, which are estimated to hold about 1.8 trillion rupees in cash and equivalents. The government has identified 17 CPSEs with a cash surplus and is assessing their capital expense needs. It is advising them to either buy back shares or pay out higher dividends. The government began using share buybacks to generate revenue in 2013. Since then, it has raised about 240 billion rupees using this method, well over a quarter of the total disinvestment proceeds for the same period. Last year, the government also told CPSEs to pay a dividend of 30 percent of their profits or 5 percent of their net worth, whichever was higher.

Moreover, the government is considering mergers and acquisitions for some of the dominant CPSEs, with the goal of making them as big as their global competitors. There has been talk of merging some of the smaller banks with the State Bank of India, potentially making it one of the world’s 50 biggest banks. Likewise, the government is considering merging Oil and Natural Gas Corporation, which dominates the upstream petroleum market, and Indian Oil Corporation, which dominates the downstream market. The new entity could be worth more than $100 billion. Another possibility is merging other companies in the upstream or downstream markets to create a couple of large, specialized firms.

It is unclear whether these huge entities, by virtue of their dominance in the domestic economy, would be efficient or able to serve consumers better. Given the Indian government’s record, these large CPSEs could simply become handmaids to those in power.

Modi’s Priority

Prime Minister Modi may proclaim that “the business of government is not business,” but his government’s actions show that it is very interested in the CPSEs. He seems keener on maximizing their revenue than reducing the government’s role in the economy and creating a competitive environment. Those who hoped for substantive market-oriented reforms and privatization would do well to temper their expectations.

At the same time, the government cannot lose sight of its fiscal deficit target of 3.2 percent of GDP in the current year. Anything higher will not please rating agencies and investors, while consumers will dislike the attendant increase in inflation.

Nevertheless, the government is trying to keep the economy growing by increasing public investment, especially in infrastructure and social welfare. Lack of private sector investment, with the banks burdened with nonperforming assets, has not helped. Better asset management is therefore the government’s top priority, and not disinvestment, deregulation, liberalization or privatization. It will use all its options to squeeze every rupee out of the CPSEs. This approach is likely to skew company decision-making and increase corruption.

The only way Mr. Modi could perhaps improve the performance of CPSEs, at least for a short period, is to enhance their sector dominance and protective privileges. Liberalization and privatization will have to wait.

Barun S. Mitra is a writer and commentator on current affairs on a range of issues from economic development, environmental quality and political participation. He is the founder and Director of the Liberty Institute, based in New Delhi.